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March 2023 Performance Review

April 6, 2023

Despite the recent stress in the regional banking industry, both the stock and bond markets performed well last month. As a result of the situation, hundreds of billions of dollars left banks and flowed into money market funds that invest in Treasury bills, which now offer close to a 5% yield. Furthermore, the ten-year government bond rate has dropped to around 3.3% from its peak of almost 4% in late February, and is now a full percentage point lower than it was last October. This drop in rates could potentially benefit banks, as the main problem they have faced so far is losses on their loans due to rising interest rates. Additionally, the lower rates may lead to increased activity in the real estate market.

In March 2023, our Conservative portfolio gained 2.52%, while our Aggressive portfolio gained 2.13%. Our benchmark Vanguard funds for the same period were Vanguard 500 Index Fund (VFINX) up 3.67%, Vanguard Total Bond Index (VBMFX) up 2.56%, Vanguard Developed Mkts Index (VTMGX) up 2.63%, Vanguard Emerging Mkts Index (VEIEX) up 2.54%, and Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 2.79%.

Last month, the stocks that experienced the biggest gains were often those that had the most significant declines in 2022. Precious metals funds saw an increase of over 10% as investors speculated that the Federal Reserve would need to lower interest rates and take a more relaxed approach to combating inflation due to the recent bank panic. Additionally, many investors sought out supposedly safe assets during the crisis. However, it should be noted that gold has a questionable track record when it comes to protecting against financial crises.

In March, the main action in the stock market was in large-cap growth and technology stocks, which saw gains of 5 to 6% in most funds in these areas. Our recently re-added Vanguard Communication ETF (VOX) fund was our top performer, with a return of 6.87%. Additionally, our single country funds performed well and outperformed the S&P 500 as the US dollar weakened.

There's a growing myth that the US dollar is losing its reserve status. Firstly, given our large investments abroad, a drop in the dollar wouldn't be all that bad. Secondly, it's highly unlikely to happen in my lifetime. Other countries simply don't have what it takes — it requires a combination of a large economy, stable inflation (or at least more stable than others), the ability to create money at will (as we've just done to address issues in the banking system), and attractive property rights, taxes, and non-restrictive capital controls (sorry, China). So, don't hold your breath.

We were able to keep pace with the globally balanced Vanguard STAR fund, thanks to strong returns on our bond investments. As interest rates decreased, we saw a near 6% increase in Vanguard Extended Duration Treasury (EDV) and a close second with Vangaurd L/T Treasury (VGLT). Additionally, foreign bonds did well, with iShares JP Morgan Em. Bond (LEMB) seeing a 3.18% increase, outperforming the bond index. Our underperforming funds were mostly shorting, notably our inverse Bitcoin bet Proshares Short Bitcoin (BITI), which fell nearly 25% as crypto enthusiasts believe the banking crisis will only increase the likelihood of digital currencies taking over banking. Banks receive a Fed loan when they have trouble and all depositors receive a bailout. The fact that Roku received their $500 million back from Silicon Valley Bank while Mr. Roku watcher lost his $50,000 investment at FTX highlights why banks are safer than crypto – not the other way around.

Regarding the current state of the markets, the primary area of concern is the collapse of banks. Let's examine the situation.

The recent banking crisis was not caused by an economic downturn or loan defaults, as is typical in banking problems. Rather, it was the result of regional banks, which are subject to less stringent regulations put in place after the Great Recession, taking in a large amount of deposits, particularly in response to the trillions of dollars distributed by the government in response to the Covid pandemic. These banks paid very low interest rates on these deposits, while making loans at 3-6% and investing in US government bonds that yielded only 1-2%. Thanks to rapid rate increases to fight inflation, the value of these government bonds fell by 10-20%, as did the banks' loans (which are not marked to market), the banks found themselves sitting on trillions of dollars in paper losses, including nearly a trillion in government bonds.

This alone would not have been a major problem, except that when short-term interest rates rose to nearly 5%, the banks attempted to maintain their profits by continuing to pay almost nothing on deposits. Some banks that dealt primarily with uninsured depositors, who held more than $250,000 in the bank, took advantage of looser rules and invested aggressively, without maintaining sufficient cash to handle potential liquidations or making questionable loans. Some even opened their banks to "hot money" from the cryptocurrency industry. When some of their largest balance clients, with $50 million to $500 million in deposits, realized that the banks were making risky loans to themselves and their tech companies, and needed to raise capital, they began an old-fashioned bank run, only at internet speed.

This has resulted in over $20 billion in losses for the Federal Deposit Insurance Corporation (FDIC), as well as hundreds of billions of dollars in Federal Reserve loans to enable other regional banks to handle withdrawals. The best case scenario is that lending will be reduced for years and bank profits will suffer, not just from the shrinking spread between the rates banks lend and borrow at, but also due to the fact that the "good" banks will be paying for the FDIC bailouts for years with higher insurance fees. Additionally, there will likely be increased regulations on mid-size banks.

In some ways, this is exactly what the Federal Reserve wants: to remove excess money from the banking system and slow down the economy. Stocks have done well during this crisis because investors anticipate that the worst is behind us and that the Fed will need to lower interest rates to stimulate the economy in the coming months. However, this is an overly optimistic view. There is an equally likely scenario where investors can earn safe, relatively high bond yields now and then switch to stocks when the economy falters and interest rates fall. The "buy now" strategy assumes that such a sale will never happen, but this is risky because the market can be volatile, as was seen during the Covid pandemic when stocks initially fell by nearly 40%, only to be almost completely restored in just a few months of zero interest rate policy.

It might be wise to wait for a true panic before making the switch from bonds to stocks.

Stock Funds1mo %
Vanguard Communications ETF (VOX)6.87%
Franklin FTSE Japan ETF (FLJP)4.77%
Franklin FTSE Germany (FLGR)4.10%
Franklin FTSE China (FLCH)3.91%
Franklin FTSE South Korea (FLKR)3.80%
[Benchmark] Vanguard 500 Index (VFINX)3.67%
Invesco CurrencyShares Euro (FXE)2.68%
Vanguard FTSE Developed Mkts. (VEA)2.63%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)2.63%
VanEck Vectors Pharma. (PPH)2.62%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)2.54%
Vanguard FTSE Europe (VGK)2.46%
ProShares Decline of Retail (EMTY)1.19%
Vangaurd All-World Small-Cap (VSS)0.87%
Franklin FTSE Brazil (FLBR)0.56%
NightShares 2000 (NIWM)0.24%
UltraShort Bloom. Crude Oil (SCO)0.00%
Vanguard Value Index (VTV)-0.47%
Homestead Value Fund (HOVLX)-0.95%
LeatherBack L/S Alt. Yld. (LBAY)-1.57%
Proshares Short High Yld (SJB)-1.76%
ProShares UltraShort QQQ (QID)-16.68%
Proshares Short Bitcoin (BITI)-24.39%
Bond Funds1mo %
Vanguard Extended Duration Treasury (EDV)5.96%
Vangaurd L/T Treasury (VGLT)4.67%
Vanguard Long-Term Bond Index ETF (BLV)4.62%
iShares JP Morgan Em. Bond (LEMB)3.18%
[Benchmark] Vanguard Total Bond Index (VBMFX)2.56%

February 2023 Performance Review

March 4, 2023

The strong recovery in bonds and stocks from the lows of 2022 that continued into January came to an abrupt halt in February. Bonds are now essentially flat for the year while the stock market gains, which almost broke 10%, have been cut in half. The hardest-hit stocks of last year have rebounded far more than 10% from their lows (but are still down far more than the broader market). This reversal of stocks and bonds puts a balanced portfolio up around 2–3% for the year. International stocks are holding up a bit better, though emerging markets were hit hard in February. With rates going back up, the U.S. dollar is recovering losses from the past few months, also weighing on our international funds.

Our Conservative portfolio declined 3.74% while our Aggressive portfolio declined 4.13%. Benchmark Vanguard funds for February 2023 were as follows: Vanguard 500 Index Fund (VFINX), down 2.44%; Vanguard Total Bond Index (VBMFX), down 2.55%; Vanguard Developed Mkts Index (VTMGX), down 3.40%; Vanguard Emerging Mkts Index (VEIEX), down 6.27%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, down 3.20%.

The weight of double-digit drops in Franklin FTSE Brazil (FLBR) and Franklin FTSE China (FLCH) as well as 3–7% hits to our bond funds pulled our portfolios down more than the benchmarks in February, leaving us barely above water for the year, while the S&P 500 is up 3.56% in 2023.

Our only winners were short funds last month. Of the hundred-plus fund categories available to investors, only short-term bonds and bank loans were up at all—and both under 1%. Some of our losses were after big run-ups in January, notably Vanguard Communication ETF (VOX), which was down 4.07% yet still up over 10% for the year. Our recently added LeatherBack L/S Alt. Yld. (LBAY) dove 5.73% and is down about as much for the year. The fund is somewhat similar to a fund we use in our managed accounts, Vanguard Market Neutral, and owns stocks while having short positions in some of the market's formerly highest flyers—questionable recent IPOs and trendy innovation stocks. These formerly hot stocks were down sharply last year but rebounded into the deep double digits in January, leading this fund to fall. The king of all future stocks, Tesla, has almost doubled since the bottom last year.

Recently added NightShares 2000 (NIWM) was down 5.88% for the month and is slated for removal from our portfolios. Unfortunately, this historical anomaly-based ETF hasn't come close to living up to the promise of an interesting risk–reward tradeoff by avoiding stocks during the day (the fund owns stock futures overnight). Most historical patterns end after investors catch on—but this one was early enough to seem workable.

Rounding out our weakness was the Euro slipping back down, sending Invesco CurrencyShares Euro (FXE) down 2.64%. Meanwhile, cryptocurrencies are in their own half-baked resurgence after the crash last year, sending Proshares Short Bitcoin (BITI) down 1.14% after a brutal January for this inverse Bitcoin fund. Surprisingly, the trouble keeps coming to companies in the crypto or digital currency area, from regulatory to more recently a run on a crypto-friendly bank. The Crypto faithful—or rather deluded—seem happy just hoarding the digital tokens and don't care if an actual business other than gambling comes to fruition after around a decade. This is not how the Internet and smartphone went down, disproving the theory that crypto is the next major innovation to take off and change lives and make a fortune “for the brave,” to misquote a recent commercial for crypto gambling by a famous actor.

It looked like the worst was behind the bond market, but rates have gone back up to roughly 4% for 10-year government bonds, sending mortgages back up toward 7%. While inflation is slowing (so far), it is definitely not falling fast enough to encourage the Federal Reserve to stop raising rates, much less lower rates as was the expectation a few months ago, which can risk inflation rising anew. T bills now pay around 5%, which is looking more attractive by the day. The main downside is that rates will go back down during the next mini-crisis. This will leave you at near 0% for who knows how long while stocks take off, keeping investors in the same uncomfortable position of early 2022—earn low yields or buy pricy stocks.

The economy is still hot. More of a surprise, the housing market hasn’t adjusted to reflect the new reality of near 7% mortgages. More of a mystery is how the commercial office market is hanging in there with the twin problems of rising rates and low occupancy in our new work-from-home reality.

High-risk debt hasn't tanked any harder than investment-grade bonds since the expectation is that the economy will remain strong enough (and inflation high enough) to allow the issuers of all the questionable debt to remain solvent. While the actual path to rising defaults could be slow, the realization defaults that could be coming can hit prices fast.

Nobody knows where inflation is going here or abroad. There is a “good news is bad news” game going on: strong economic data can hurt the market as investors speculate that it will lead the Fed to send rates too high, causing a financial calamity. The worst fund category last month was precious metals, down over 12% after a strong start to the year. Typically this area does best during rising inflation fears and falls as these fears subside. The worst thing for gold is a hawkish Fed raising rates to 6%, while a gold bug that holds no-yield gold then is faced with deflation caused by the Fed's high rates.

We're eventually going to find out if this inflation boomlet is a blip just like the years after WW2, in which case raising rates high is a bad move, or if it is the beginning of a new era of '70s-style economic stagnation and stubbornly high inflation.

Raising rates is a dangerous game because it takes time for the economy to slow down, and—by then—asset prices may have crashed. The safer move would be to raise taxes and cut spending and run a budget surplus, similar to post-WW2, to get the excess money out of the system. Today is more like the early '80s—there is no political will to remove money from voters’ hands, so we have to see what Fed rate hikes do.

Stock Funds1mo %
UltraShort Bloom. Crude Oil (SCO)5.17%
ProShares Decline of Retail (EMTY)4.07%
Proshares Short High Yld (SJB)2.23%
ProShares UltraShort QQQ (QID)0.14%
Proshares Short Bitcoin (BITI)-1.14%
Vanguard FTSE Europe (VGK)-1.71%
[Benchmark] Vanguard 500 Index (VFINX)-2.44%
Invesco CurrencyShares Euro (FXE)-2.64%
Franklin FTSE Germany (FLGR)-2.84%
Homestead Value Fund (HOVLX)-2.86%
Vangaurd All-World Small-Cap (VSS)-3.15%
Vanguard Value Index (VTV)-3.24%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)-3.40%
VanEck Vectors Pharma. (PPH)-3.43%
Vanguard FTSE Developed Mkts. (VEA)-3.47%
Vanguard Communications ETF (VOX)-4.07%
Franklin FTSE Japan ETF (FLJP)-4.36%
LeatherBack L/S Alt. Yld. (LBAY)-5.73%
NightShares 2000 (NIWM)-5.88%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)-6.27%
Franklin FTSE South Korea (FLKR)-7.41%
Franklin FTSE Brazil (FLBR)-10.39%
Franklin FTSE China (FLCH)-10.72%
Bond Funds1mo %
[Benchmark] Vanguard Total Bond Index (VBMFX)-2.55%
iShares JP Morgan Em. Bond (LEMB)-2.78%
Vangaurd L/T Treasury (VGLT)-4.73%
Vanguard Long-Term Bond Index ETF (BLV)-5.13%
Vanguard Extended Duration Treasury (EDV)-6.37%

January 2023 Performance Review

February 7, 2023

Stocks and bonds rebounded sharply in January as investors upped bets on a so-called soft landing in the economy. Expectations of falling inflation without a serious recession led to a flurry of dip buying, notably in the hardest-hit areas of last year. Falling longer-term interest rates pushed up bond prices but imply low inflation and probably a recession are in the cards. Economic numbers are by and large very good, considering how fast interest rates have risen, but then it takes time for rate increases to help start a recession, historically.

Our Conservative portfolio gained 5.80%, and our Aggressive portfolio gained 5.58%. Benchmark Vanguard funds for January 2023 were as follows: Vanguard 500 Index Fund (VFINX), up 6.28%; Vanguard Total Bond Index (VBMFX), up 3.19%; Vanguard Developed Mkts Index (VTMGX), up 8.65%; Vanguard Emerging Mkts Index (VEIEX), up 7.77%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 7.20%.

With the dramatic rebound in January, our portfolios clawed back a good chunk of last year’s losses all in one month. This third rebound attempt since the stock and bond market turned way down just over a year ago might already be petering out. The economy is looking a little too hot, which could keep the Federal Reserve in inflation red-alert mode. With the latest rate hike, we’re just under 5% on safe risk-free cash, which somehow hasn’t crashed the economy, housing, or stock market so far. The expectation is these rates won’t last, so why load up the truck on cash?

One reason for the excitement is that longer-term rates have been heading down since October, which is why bond funds are doing well again after 2022 proved to be the worst calendar year for investment-grade debt pretty much ever. In theory, if the economy wasn’t going to slow down much and this was a great time to buy stocks after last year’s dip, interest rates would be flat or moving up. Bonds are saying recession; stocks are saying no recession. It is possible there is some sort of Goldilocks economy market scenario where longer- term rates are 2–3%, inflation down to 2%, and the economy and stocks are strong.

At the top of our hits was recently added Vanguard Communication ETF (VOX), up 15.02% as investors piled into hard-hit tech and communications stocks, pushing this category to the top 3% of all fund categories last month. The US dollar is weakening after a strong year on expectations our rates are not going any higher. This, plus bargain shopping, led to many foreign funds rising more than the S&P 500; notably Franklin FTSE Germany (FLGR), Franklin FTSE China (FLCH), and Franklin FTSE South Korea (FLKR) up over 13% as a group.

Value stocks did very well compared to growth stock in 2022. While both were down, growth stocks were down around 33% while value stocks were down around 2%. This 31% performance gap is the largest on record since the unwinding of the dot com bubble in 2000. The years 2022 and 2000 are the biggest gaps since at least the late 1970s. As it turns out, during a stock boom, investors flock to growth stories and overpay.

So far in 2023 this trend is reversing, with growth leading the way by far. It is too soon to tell if the relative bottom is in in growth stocks. It is just as possible that both will fall more together as the growth fluff is gone, but the overall market is still pricy relative to now high interest rates.

Our value- and dividend-oriented holdings performed poorly last month, with VanEck Vectors Pharma. (PPH) up just 0.77% and our value funds Homestead Value Fund (HOVLX) and Vanguard Value Index (VTV) both up only about half as much as the S&P 500. The real drags were our shorts; notably, Proshares Short Bitcoin (BITI) down 30% as deluded gamblers—or visionaries, depending on your opinion of digital currencies—piled back into Bitcoin after a collapse in 2022. Digital “asset” funds (an oxymoron) were up around 40% last month but are still down 44% over the last 12 months and are negative over the past 5 years. The only real weak areas in January were utilities funds, down fractionally, and funds that invest in India, also down slightly.

We even had big gains in rate-sensitive bonds, with Vanguard Extended Duration Treasury (EDV) up 10.18%, Vanguard Long-Term Bond Index ETF (BLV) up 7.26%, and Vangaurd L/T Treasury (VGLT) up 7.14%. Both have a long way to go to regain old highs; in fact, they may never hit old highs unless rates plunge anew. That said, we’re also enjoying the higher yields now. The worst thing for bonds would be some sort of panic selling in the bond market if investors decide we can’t get inflation or deficit spending under control. We’re considering adding back inflation-adjusted bond funds, as pricing is now favorable compared to Series I bonds purchased directly from the Treasury.

Stock Funds1mo %
Vanguard Communications ETF (VOX)15.02%
Franklin FTSE Germany (FLGR)13.70%
Franklin FTSE China (FLCH)13.37%
Franklin FTSE South Korea (FLKR)12.94%
Vanguard FTSE Europe (VGK)9.56%
Vanguard FTSE Developed Mkts. (VEA)9.03%
Vangaurd All-World Small-Cap (VSS)8.76%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)8.65%
Franklin FTSE Brazil (FLBR)8.36%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)7.77%
Franklin FTSE Japan ETF (FLJP)7.32%
[Benchmark] Vanguard 500 Index (VFINX)6.28%
Vanguard Value Index (VTV)2.79%
Homestead Value Fund (HOVLX)2.68%
Invesco CurrencyShares Euro (FXE)1.58%
NightShares 2000 (NIWM)1.40%
VanEck Vectors Pharma. (PPH)0.77%
UltraShort Bloom. Crude Oil (SCO)0.55%
LeatherBack L/S Alt. Yld. (LBAY)0.37%
Proshares Short High Yld (SJB)-3.26%
ProShares Decline of Retail (EMTY)-7.02%
ProShares UltraShort QQQ (QID)-18.56%
Proshares Short Bitcoin (BITI)-30.18%
Bond Funds1mo %
Vanguard Extended Duration Treasury (EDV)10.18%
Vanguard Long-Term Bond Index ETF (BLV)7.26%
Vangaurd L/T Treasury (VGLT)7.14%
iShares JP Morgan Em. Bond (LEMB)3.54%
[Benchmark] Vanguard Total Bond Index (VBMFX)3.19%

December 2022 Performance Review

January 5, 2023

2022 was one of the worst calendar years for the stock market. The 18.15% drop in the S&P 500 (including dividends and index fund fees) was the seventh worst annual hit since the 1920s. This in itself is not that remarkable. The interesting part was that the bond market was also down 13.25% – essentially the worst year in history for the bond market.

For the month, our Conservative portfolio fell by 1.30%, while our Aggressive portfolio dropped by 1.21%. Benchmark Vanguard funds for December 2022 were as follows: Vanguard 500 Index Fund (VFINX) down 5.77%; Vanguard Total Bond Index (VBMFX) down 0.61%; Vanguard Developed Mkts Index (VTMGX) down 2.16%; Vanguard Emerging Mkts Index (VEIEX) down 2.10%; and Vanguard Star Fund (VGSTX), a complete global balanced portfolio, down 3.40%.

For the year, our Aggressive portfolio was down 11.36% or around 62% of the stock market’s downside, while our more bond-heavy Conservative portfolio slid a whopping 15.31%, representing almost 85% of the stock market decline. There was no help from abroad as Vanguard Developed Mkts Index (VTMGX) was down 15.32% and Vanguard Emerging Mkts Index (VEIEX) was down 17.90%.

Our favorite overall benchmark (because it is globally balanced at roughly 60% stocks 40% bonds, with low fees) is Vanguard Star Fund (VGSTX), and this moderate risk fund was down 17.99% in 2022. The only year previously that this fund had been down more than 10% since 1987 was in 2008, when it had a return of -25.1%. So, the only good thing we can say is that both our portfolios beat this fund by falling less, which is also what happened in 2008.

It is hard to find a balanced total portfolio fund that has fallen by less than 15% in 2022, highlighting what a tough year it has been for lower-risk investors. The best performing Vanguard total portfolio fund from 2022 was the low-risk and low-fee Vanguard Target Retirement Income fund (VTINX). This fund is for those in retirement looking for income and is comprised of 67% bonds, 3% cash and 30% stocks. It was down 12.74% in 2022. Factor in near 10% inflation and this was a bad year for those in retirement.

The Vanguard Balanced Index (VBINX) has been around since 1993. This year it was down 16.97%. The only other time this fund has been down by more than 10% was in 2008, when it fell by 22.21%. The key difference is that in 2008 the stock market was down just over 37% and it was the second-worst calendar year on record for stocks, after 1931. What makes this year unusually bad is not that stocks were down by around 18%, but that because of the poor performance of the bond market, balanced ‘safe’ portfolios were hit almost as hard as in 2008 when stocks were down almost 40% (and investment-grade bonds were up).

The Vanguard Total Bond Index (VBMFX) was launched in 1986. Until this year’s 13.25% drop, the worst year for that fund had been a -2.66% return in 1994. Vanguard Long-Term Investment-Grade Inv (VWESX) invests in longer-term, more rate-sensitive bonds. Launched in the 1970s, its previous worst year was 1999 when the Fed raised rates to sink the dotcom bubble, sending the fund down 6.23%. This year the fund was down 25.62% – and that is after a rebound late in the year as rates slipped on recession fears. In late October this fund was down 32.8%! Many bond funds now have near-zero 10-year total returns – also a first by a wide margin.

Fortunately, we have cut back somewhat on longer-term bond funds in recent years, but the lower-duration bond funds we had added were still down by double digits. We should have just kept the funds in cash and accepted the 0% returns (which are now over 4%), but the fear of earning nothing with near 10% inflation, and the ‘knowledge’ that these safer bond funds ‘never’ fall by more than 10% proved a disaster of sorts.

Speaking of disasters, the twin disasters for the bond market were the Fed raising rates much faster than in the past to stop the multi-decades-high inflation, partially if not largely, created by the loose monetary policy of low rates and new money creation, AND a low starting yield. In other words, if rates had been 4% and the Fed had raised them to 6% relatively quickly, the price hit would have been partially offset by the 3% and rising yields. However, the starting yield was 1.7% in January for 10-year government bonds so the move to 3.7% (and briefly over 4%) was all price pain and little yield gain.

Note that the broad ‘bond market’ in index funds is investment-grade (no junk bonds) debt and since most bonds have less than 10 years to maturity, the bond market index is low risk in terms of rising rates and default risk. The bond market has a duration of less than 7, meaning that with a 1% rise in rates you lose around 7% in price. The average credit rating is AA as half the bonds are government-backed.

Rising rates ultimately hit stocks (and eventually real estate) because a company that earns 5% a year (20 P/E ratio) and pays out a 2% dividend isn’t as valuable when you can buy a safe 5% bond with essentially no default risk. A rental property that yields 2%-3% after expenses isn’t a very compelling investment if you can get inflation plus 2% in a no-default-risk bond. Note that currently even with a price pull-back of about 25% in 2022, the Vanguard REIT Index fund (VGSLX) yields just 2.2%, not including capital gains from property sales and return of capital.

The scary part is no longer bonds (or at least investment grade bonds), but stocks (and real estate). The current dividend yield on stocks after a top-10 bad year is STILL just 1.7%. Considering that riskier stocks and recent IPOs and cryptocurrencies are down 40%-90%+ across the board, with the Nasdaq index down 33% in 2022, the fact that stocks are still this pricy is remarkable.

Meanwhile, no-risk T-bills pay 4.3%. Investors are basically betting that rates will go back down soon and stocks are reasonably priced for the near-future sub-2% rates. The same ‘logic’ is being applied in the property market, which hasn’t yet taken a big hit. Sellers and some buyers are assuming that sub-4% mortgages are just around the corner, so why mark down the price by 20% to adjust for high rates? In the few deals happening in an otherwise frozen market, buyers probably think, ‘No problem, we’ll just refinance in a few years at a lower rate’. It is possible, but such speculation is just the kind the Fed is trying to end in the economy to bring down inflation. More likely to support the property market than 3% mortgages being just around the corner, is inflation not dipping below 4% and rent increases supporting the currently high property prices. Another problem with the 'buy now, refi at 3% later' mentality is 3% mortgages will likely occur during the next mini financial crisis and your recently bought 7% mortgage property may be down 30% in price and ineligible for a refi without a 2009 grade Government program to allow underwater refis.

We’ve seen much harder hits to stocks over more than a calendar year. The 2000 bubble really broke down over three years, with the Nasdaq down over 20% each year for three years in a row, amounting to a total loss of almost 80%. Could it happen again? Probably not for the tech index as a whole, as many of these companies are now established and make money; it is unlikely a capitalization-weighted index of companies including Apple (AAPL) and Microsoft (MSFT) would fall by 80% again.

‘Junky’ growth and bubble stocks are already down by 80%. A more likely worst-case scenario is a 50% top-to-bottom Nasdaq slide and a 90%+ slide in formerly popular stocks of the future (with many worth zero). This relates to innovation stocks such as those in the still (remarkably) popular ARK Innovation ETF (ARKK), which was down 67% in 2022, after a 23% drop in 2021; a total drop from the 2021 peak to the end of 2022 of around 80%, just as happened with the Nasdaq in 2000–2003. In recent months even the mighty Tesla (TSLA) bubble has finally popped, sending its stock down 65% in 2022. We’ve been waiting for these bubbles to pop and are glad to see the froth leave the market. Unfortunately, investors’ enthusiasm for these busted boom stocks is still too high.

It is likely our focus on foreign stocks would have helped somewhat this year had it not been for the war in Ukraine and the ensuing troubles in European economies, which resulted in a fast-rising US dollar that has only recently cooled off. Even with the recent rebound, we took some bruising hits abroad, with a 28.06% drop in Franklin FTSE South Korea (FLKR) and 24.72% drop in Franklin FTSE Germany (FLGR). China was at one point down over 40%, but a year-end sharp rebound has left us with just a 22.78% drop in Franklin FTSE China (FLCH). The stock winners were short funds, led by a 66.3% gain in ProShares UltraShort QQQ (QID), a perennial loser except when tech stocks tank, which we’ve been waiting for since the Covid stock bubble. Value oriented stocks did fine, with Vanguard Value Index (VTV) down just 2.1% for the year. VanEck Vectors Pharma. (PPH) was up 2.61% and Franklin FTSE Brazil (FLBR) scored a 10.78% year, being a beneficiary of rising commodity prices. Homestead Value Fund (HOVLX) was down just 5.5% for the year. Value stocks are no longer such a good deal relative to growth stocks.

Our biggest hits were actually in bonds, with a near 40% drop in Vanguard Extended Duration Treasury (EDV) and a 26.93% hit to Vanguard Long-Term Bond Index ETF (BLV). More frustrating were our losses in recently exited mortgage bonds, which only fell slightly less in 2022 than the inflation-adjusted bond funds we dumped for being over-priced as inflation increased. Former holding, Vanguard Mortgage-Backed Secs ETF Vanguard Mortgage-Backed Securities (VMBS) was down 11.9% in 2022, only slightly better than the former holding (sold in early 2021) of Schwab US TIPS Schwab US TIPS (SCHP) which was down 12.02% in 2022. We should have just gone to 0% yield cash.

Surprisingly, riskier bonds didn’t perform much worse than investment-grade bonds – the whole crash was primarily a rate adjustment rather than a credit risk one; risky bonds did not fall hard while safe bonds did well, as is more typical of a weakening economy. Our best performing bond fund was iShares JP Morgan Em. Bond (LEMB), down just 10.73% in 2022, despite being significantly riskier than the intermediate-term top-rated government-backed mortgages, which fell more in 2022. Part of this was due to the high-dividend yield on the emerging-market bonds offered some counter to the decline in bond prices, unlike low-yield investment-grade bonds this year. The rising US dollar slipping near the end of the year helped this fund recover.

One thing investors should learn from 2022 is that more directly ‘inflation’-oriented investments can do well during rising inflation, but often become over-priced and tank when inflation fears subside. This is why we recommended the Series I bonds purchased direct from the US Government last year – they don’t trade at a premium during periods of inflationary fear. Incidentally, exchange-traded TIPS are now as good or even better priced, with a guaranteed return above inflation (not just matching) over 5-10 years, though there is still market price risk that could cause another 10%+ drop if rates go up more or inflation expectations drop which could happen in a sharp economic decline.

The only really hot area in 2022 was energy and other commodities (though not gold as precious metals category funds were down around 15% for the year). The fund we sold way too soon in late November 2021, Vanguard Energy (VDE), was up an astounding 62.86% in 2022 (after a 56.21% return in 2021). So much for fossil fuels dying out as an energy source. We could really have used that boost in 2022.

But enough about the past. The new investing game for stocks and bonds has become speculating on when the Fed will go back to the world we had all become too used to – 0% to 2% rates at or below inflation that made property and stocks the only game in town. The answer is probably quite a bit longer than anyone expects. The Fed isn’t going to cause a second boom in inflation by going back to the old game of low rates too soon, after being asleep at the wheel when inflation took off. That said, what could lead the Fed to reverse course is some sort of panic in the debt markets – stocks and property falling alone won’t do it. Such a panic would likely happen at significantly lower stock prices, so at that time, getting ahead of the next money-creation wave could be a possibility.

In the meantime, 4%+ safe yields are a good deal. The real question is how far out should these rates be locked in? T-bills at 4.3% are a welcome improvement after a decade plus of essentially no return on such investments, but they may only last two years (but not 6 months as some expect) before returning to sub-2%. The risk of buying 10-year or longer bonds (which have already come down in yield from the peaks of a few months ago) is that higher rates could mean another 10%-20% drop in bond prices.

At some point when a real recession hits, bond yields will fall, boosting bond prices and creating a good opportunity to shift to stocks that will likely be at lower prices than today.

On a positive note, the future for lower risk investors should be brighter. The trailing 10 year annualized return on a bond index fund is 0.9% — which is a little higher than money market funds and T-bills at roughly 0.6%. For most of this period inflation was low but we've still had 2.6% per year inflation largely thanks to recent trends. In other words, investors seeking safety and yield have lost 2% a year to inflation, or about 20% of their purchasing power.

Stock Funds1mo %
ProShares UltraShort QQQ (QID)20.24%
ProShares Decline of Retail (EMTY)6.61%
Invesco CurrencyShares Euro (FXE)2.91%
Franklin FTSE China (FLCH)2.40%
Proshares Short High Yld (SJB)1.96%
Proshares Short Bitcoin (BITI)1.75%
VanEck Vectors Pharma. (PPH)1.24%
LeatherBack L/S Alt. Yld. (LBAY)-0.36%
UltraShort Bloom. Crude Oil (SCO)-1.24%
Vanguard FTSE Europe (VGK)-1.68%
Franklin FTSE Japan ETF (FLJP)-1.76%
NightShares 2000 (NIWM)-1.79%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)-2.10%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)-2.16%
Vanguard FTSE Developed Mkts. (VEA)-2.19%
Vangaurd All-World Small-Cap (VSS)-2.29%
Franklin FTSE Germany (FLGR)-2.62%
Vanguard Value Index (VTV)-3.30%
Homestead Value Fund (HOVLX)-3.50%
Franklin FTSE Brazil (FLBR)-4.88%
[Benchmark] Vanguard 500 Index (VFINX)-5.77%
Franklin FTSE South Korea (FLKR)-6.14%
Vanguard Communications ETF (VOX)-7.16%
Bond Funds1mo %
iShares JP Morgan Em. Bond (LEMB)1.01%
[Benchmark] Vanguard Total Bond Index (VBMFX)-0.61%
Vangaurd L/T Treasury (VGLT)-2.28%
Vanguard Long-Term Bond Index ETF (BLV)-2.29%
Vanguard Extended Duration Treasury (EDV)-2.99%

November 2022 Performance Review

December 6, 2022

November was a great month for pretty much anything that was down over 20% over the last year or so. This current stock market rebound started in late September and has boosted the S&P by over 10% from the lows of the year, and by even more for harder hit markets. The US market is still down by a double-digit percentage for the year. We had a similar fast rebound from mid-June to early August. It ultimately led to lower lows for the year.

Our Conservative portfolio gained 8.31% and our Aggressive portfolio gained 7.03%. Benchmark Vanguard fund performances for November 2022 were as follows: Vanguard 500 Index Fund (VFINX), up 5.58%; Vanguard Total Bond Index (VBMFX), up 3.69%; Vanguard Developed Mkts Index (VTMGX), up 13.02%; Vanguard Emerging Mkts Index (VEIEX), up 14.42%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 6.82%. Our Aggressive portfolio is now down 10.27% for 2022 compared to the 13.14% slide in the S&P 500. Our Conservative portfolio is still down 14.19%, even with the sharp rebound, as yield-oriented investments have been hit harder than the US stock market in 2022.

Foreign markets are now benefiting from a falling US dollar, reversing the pattern of much of the last year. Our high relative interest rates and general safety, plus economic distance from the Russia–Ukraine war, led to capital inflows and pushed up the value of the US dollar.

The current rebound in stocks is based on the likely overly optimistic assessment that the Fed will slow rate increases soon, that the rate of inflation will continue to fade, and that the economy will avoid a recession. The related boost is from the rebound in the bond market. Long-term rates have turned lower, perhaps because inflation expectations are falling, but likely also because 4%+ from a risk-free bond seems like a good yield to lock in. As rates go back down, the value of stocks (and real estate) goes up.

The highlights from our portfolio include a sharp 30.76% rebound in Franklin FTSE China (FLCH) as an overdone slide in Chinese stocks reversed course abruptly. Funds investing in China are still down over 20% for the year. Almost all of our foreign stock funds—except for Franklin FTSE Brazil (FLBR), which was down 3.73%—were up by double-digit percentages in November. Brazil has been hot and is up over 10% for the year, largely due to being seen as a commodity beneficiary. Our only other losers in November were funds that short. Longer term bonds had a great month but are still down over 20% for the year. Vanguard Extended Duration Treasury (EDV) rebounded 10.08% while Vanguard Long-Term Bond Index ETF (BLV) scored an 8.56% return.

If you exclude the heavy tech weightings in the S&P 500 and Nasdaq, stocks aren’t even down that badly this year. The Dow through the end of November, including dividends, was down around 3%. The S&P 500 is down only 13.1% (again with dividends) for the year, while tech stocks are down just over 30%, even with the recent rebound. Much of this Dow outperformance of the S&P 500 is due to the generally good year that value stocks are having; they are now up slightly for the year. Our own index fund in this category Vanguard Value Index (VTV) is up slightly for the year. Some of it is due to the strong performance of energy stocks, which are the number one sector, with the average energy fund up around 52% for the year.

Considering how fast interest rates have risen, it is remarkable that stocks aren’t down more this year. One way to look at it is that they aren’t down by only 13%; they are down maybe 25% from the top, adjusting for inflation. All other things being equal, most companies are worth 20% more if prices inflate 20% because earnings will just inflate with everything else. There are even benefits to companies that borrowed at interest rates that are now below the rate of inflation. They are inflating away their debts, just like locking in a mortgage at 2.5% before the value of your house zooms away with inflation.

There are risks, and high inflation is not a good thing overall. Many companies borrow short-term or with adjustable rate loans, and will have to borrow at today’s much higher rates, which can cut into profitability. The real hit, which has mostly yet to happen, is to businesses tied directly to housing. Home sales are semi-frozen, as prices are still too high to finance at current mortgage rates. In theory, inflation will boost rents and salaries and catch up with the pricing imbalance. Or housing will slide and bring down the broader economy with it, with a Fed that can’t do anything while on inflation watch. Consumer financing costs are rising and sales of financed goods in general, notably autos, will slow, which is exactly what the Federal Reserve wants.

Stock Funds1mo %
Franklin FTSE China (FLCH)30.76%
Franklin FTSE South Korea (FLKR)16.73%
Franklin FTSE Germany (FLGR)16.37%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)14.42%
Vanguard FTSE Europe (VGK)13.49%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)13.02%
Vanguard FTSE Developed Mkts. (VEA)12.55%
Franklin FTSE Japan ETF (FLJP)11.47%
Vangaurd All-World Small-Cap (VSS)11.32%
Proshares Short Bitcoin (BITI)8.06%
Homestead Value Fund (HOVLX)7.39%
Vanguard Value Index (VTV)5.99%
VanEck Vectors Pharma. (PPH)5.74%
[Benchmark] Vanguard 500 Index (VFINX)5.58%
LeatherBack L/S Alt. Yld. (LBAY)5.26%
Invesco CurrencyShares Euro (FXE)5.24%
Vanguard Communications ETF (VOX)5.14%
NightShares 2000 (NIWM)3.87%
UltraShort Bloom. Crude Oil (SCO)-2.03%
Proshares Short High Yld (SJB)-3.11%
Franklin FTSE Brazil (FLBR)-3.73%
ProShares Decline of Retail (EMTY)-6.26%
ProShares UltraShort QQQ (QID)-12.82%
Bond Funds1mo %
Vanguard Extended Duration Treasury (EDV)10.08%
Vanguard Long-Term Bond Index ETF (BLV)8.56%
iShares JP Morgan Em. Bond (LEMB)7.54%
Vangaurd L/T Treasury (VGLT)6.73%
[Benchmark] Vanguard Total Bond Index (VBMFX)3.69%

October 2022 Performance Review

November 5, 2022

The US stock market rebounded strongly in October, rising over 8%. It was an even better month for value-oriented stocks and energy stocks, which helped push the Dow up 14%, its best month since the 1970s. The Federal Reserve’s interest rate increase and press conference in early November stoked fears of even higher rates to fight inflation, and reversed some of the gains. Bonds continued to slide, and 2022 is becoming the worst year in history for the bond market. Most large foreign markets did well, but not as well as the US. Emerging market funds were down, largely because of continued troubles in China.

As a sign of how strange this year has been for investors, as of October 31 the Vanguard STAR fund was down 20.53% compared to the S&P 500’s 17.75% decline. As this globally balanced fund is only around 60% in stocks, this is a remarkable development. Bonds have declined as much as stocks have in 2022. Foreign stocks are down more than US stocks, largely because of a sharply rising US dollar. The cumulative drag of bonds, China, and shorting weighed on our returns in October. Our Aggressive portfolio has fallen slightly less than the S&P 500 this year, with a negative 16.16% return. Our Conservative portfolio is more in line with the Vanguard STAR fund and is down 20.78%.

In October our Conservative portfolio gained 2.04% and our Aggressive portfolio gained 1.02%. The performances of benchmark Vanguard funds were as follows: Vanguard 500 Index Fund (VFINX), up 8.09%; Vanguard Total Bond Index (VBMFX), down 1.38%; Vanguard Developed Mkts Index (VTMGX), up 5.91%; Vanguard Emerging Mkts Index (VEIEX), down 3.45%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 3.66%.

Value stocks did well, lifting Vanguard Value Index (VTV) by 11.73% and Homestead Value Fund (HOVLX) by 11.45%. But that, and the handful of our other funds that beat the S&P 500 last month, didn’t make up for heavy losses in longer term bonds. Our move to increase long-term bonds in June was premature. Vangaurd L/T Treasury (VGLT) was down 5.2% for the month, while Vanguard Extended Duration Treasury (EDV) fell a whopping 9.08%. Long-term bond funds in general are now down over 30% for the year – far more than the S&P 500 and more akin to technology shares.

The only really hot area was energy, up 22% for the month as oil prices headed up again. This was an area we moved into during COVID-19, when the oil price collapsed and was sold way too early. Our Franklin FTSE Brazil (FLBR) fund was up 9.89% for the month and 20.97% for the year as the country is something of a natural resource play, but we’d prefer this year’s roughly 50% gains in energy funds. Energy, commodities, and Latin America are the only fund categories up this year. Most are down by double-digit percentages.

Except for so-called digital asset funds, which own crypto-related ‘investments’ and are down 58% in 2022, the worst category of funds this year (and last month) is funds investing in China. Our own Franklin FTSE China (FLCH) was down 15.83% for the month and 42.33% for 2022 as a grab bag of political and economic issues hit the already weak market.

Long-term interest rates at over 4% for government bonds and 6% for corporate investment grade bonds will be hard for stocks to beat over the next few years, unless the Fed is unable to get inflation under 3% and the economy and earnings keep inflating at the expense of bond holders, but with no recession. More likely we’ll eventually have a fairly deep recession, falling inflation, and a return to low interest rates. This will reward locking in some longer term high yields, and give some potential upside that can be shifted into stocks at even lower prices than are on offer today.

Stock Funds1mo %
Vanguard Value Index (VTV)11.73%
Homestead Value Fund (HOVLX)11.45%
Franklin FTSE Germany (FLGR)10.57%
Franklin FTSE Brazil (FLBR)9.89%
LeatherBack L/S Alt. Yld. (LBAY)9.83%
Franklin FTSE South Korea (FLKR)9.06%
VanEck Vectors Pharma. (PPH)8.77%
Vanguard FTSE Europe (VGK)8.43%
[Benchmark] Vanguard 500 Index (VFINX)8.09%
Vanguard FTSE Developed Mkts. (VEA)6.08%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)5.91%
NightShares 2000 (NIWM)4.02%
Vangaurd All-World Small-Cap (VSS)3.66%
Vanguard Communications ETF (VOX)2.78%
Franklin FTSE Japan ETF (FLJP)2.12%
Invesco CurrencyShares Euro (FXE)0.88%
Proshares Short High Yld (SJB)-3.45%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)-3.45%
Proshares Short Bitcoin (BITI)-5.38%
ProShares UltraShort QQQ (QID)-9.55%
ProShares Decline of Retail (EMTY)-10.32%
Franklin FTSE China (FLCH)-15.83%
UltraShort Bloom. Crude Oil (SCO)-18.59%
Bond Funds1mo %
iShares JP Morgan Em. Bond (LEMB)-0.25%
[Benchmark] Vanguard Total Bond Index (VBMFX)-1.38%
Vanguard Long-Term Bond Index ETF (BLV)-3.79%
Vangaurd L/T Treasury (VGLT)-5.20%
Vanguard Extended Duration Treasury (EDV)-9.08%

September 2022 Performance Review

October 5, 2022

The hits to the bond market just keep on coming. Interest rates spiked up as inflation signs were alive and well, and the Fed hiked short-term rates by another 0.75%. The bond index was down 4.18%—a tremendous one-month hit—while more rate-sensitive longer-term bonds were down 7%+. The S&P 500 was down 9.2% as the recent rebound from the June low rapidly reversed to new lows for the year. Stocks have been rising and falling with bonds, which is why safer balanced portfolios are down so much this year.

Our Conservative portfolio declined 7.62%, and our Aggressive portfolio declined 6.36%. Benchmark Vanguard funds for September 2022 were as follows: Vanguard 500 Index Fund (VFINX), down 9.21%; Vanguard Total Bond Index (VBMFX), down 4.18%; Vanguard Developed Mkts Index (VTMGX), down 9.96%; Vanguard Emerging Mkts Index (VEIEX), down 10.17%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, down 7.84%.

For the year, our Conservative portfolio is down a whopping 22.36% while our Aggressive portfolio is down 17.01%. Ever since central banks have needed near 0% rates to keep sluggish economies out of recession, the safety value of bonds has been almost nonexistent. More stocks and a few short positions have delivered less downside risk than fewer stocks and more bonds. Risky holdings like energy and Brazil stocks have delivered positive returns this year, while safer funds investing in Europe are down 30%. It is an increasingly upside-down world.

The bond market didn’t have much positive return to spare in a slide (unlike stocks over the last decade, which are still way up) as yields have been very low for most of the post-2008 great recession era. With this year’s slide, the 10-year total return on the Vanguard Bond Index is 0.74%. The annualized inflation rate over this time has been 2.54% for a negative real return (inflation-adjusted) of 1.8%. The treasury bill return has been slightly worse, so cash really only looks good this year, not as a long-term holding.

Here is your best news: from the current yield of the bond index fund of roughly 4%, inflation would have to come in at almost 6% a year on average over the next decade to reproduce the negative inflation-adjusted return of the last decade. In other words, these are the best times to buy investment-grade bonds since the early 2000s.

For 2022, the S&P 500 is down (with dividends) 23.89%—not far off from our Conservative portfolio, shockingly, and our worst relative risk showing ever. Emerging market indexes are down 24.08% while developed markets abroad are down even more at 27.69%—odd in a down market for riskier stocks to perform better. The bond market is down 14.65% for the year, while longer-term bond funds are down 20%+. This is why Vanguard STAR, the 60/40 global balanced fund, is down 23.33% this year. At least both our portfolios are beating this solid benchmark.

While we should have had more cash, after 10-plus years of near-zero returns in cash, it gets too easy to reach for a “safe” yield of 1-2%. And then 2022 happens, and the bond market falls harder than ever before. This doesn’t mean we won’t see lower prices; however, it is time to dust yourself off and get back out on that yield curve. Stocks are down too, but other than foreign stocks, they are not at decade-plus valuation lows. The right move likely is to lock up some higher rates and, when they go back down after a bigger economic train wreck (which will boost bond prices), move the gains into even more distressed stocks.

Every fund category that doesn’t include shorting was down last month. The big hits were in real estate and China funds, both down just over 12% for the month, and both down roughly 30% for the year. Falling oil prices hit energy funds hard last month, but even with a roughly 11% hit, they are up 20% for the year. The same can’t be said for tech funds, which are now down almost 40% YTD. Oil seems to be turning back up, both from expectations that central banks are going to pause and because OPEC+ is going to cut production to maintain higher prices.

Supporting our Aggressive portfolio was a roughly 23% rise in both UltraShort Bloom. Crude Oil (SCO) and ProShares UltraShort QQQ (QID) as well as a near 8% jump in ProShares Decline of Retail (EMTY) and almost 4% in Proshares Short High Yld (SJB). It goes downhill fast from there, though most of our funds beat the S&P 500 last month. The biggest hits to our stocks were Franklin FTSE South Korea (FLKR), down 18.71%; Franklin FTSE China (FLCH), down 14.12%; and newly added Vanguard Communication ETF (VOX), down 12.5%. Bonds were all bad with all of our holdings falling harder than the bond index, topping out with a 10.2% drop in Vanguard Extended Duration Treasury (EDV).

With that being said, rates may not go up that much more—although riskier credit bonds could still collapse in a recession. The reason is that things are starting to break globally, and central banks are going to run out of room to fight inflation. The last casualty was the almost complete collapse of the UK government bond market. As leveraged investors had to unwind positions, their own central bank had to immediately start creating money out of thin air and buying bonds to support the market. Considering they are also trying to do the opposite—fight roughly 10% inflation by selling off the central bank balance sheet—this reversal was startling. It worked—possibly too well as investors now think they see the end of rate increases and the green shoots of the next low-rate cycle and are promptly jumping back into riskier stocks and commodities.

This is a dangerous game of Fed chicken. It would be the perfect time for governments to raise taxes to fight inflation and raise confidence in the bond market that debts will be paid and a debt spiral of high rates won’t happen. Instead, we have governments, foreign and domestic, left wing and right wing, state and federal, doing the opposite. We’re getting gas tax holidays and more checks in the mail. The UK is going to pay much of your energy bills (and tried to do a big tax cut), and Germany will too. This is of course the opposite of how you want to fight inflation—by reducing the amount of money consumers have to spend—and this was the foundation of the UK bond market mini-collapse. Since this subsidized demand will also send more money into Russia, where much of Europe’s energy still comes from, these populist policies are mind-boggling.

If government stimulus keeps up and central banks lose their nerve for raising rates, we may have inflation for longer than we think, and we may add back our inflation bond funds holding TIPS (which are down sharply this year). The damage to the housing market has already begun, with 7% 30-year mortgage rates. In all likelihood, home prices in formerly hot markets will fall 10-25% in the next year or so if mortgages don’t come way back down. This will cool down the economy and cause a recession in a very stupid and risky way. Apparently we’d rather avoid a small tax increase even if it means having to revisit the 2007 housing market crash.

Stock Funds1mo %
UltraShort Bloom. Crude Oil (SCO)23.34%
ProShares UltraShort QQQ (QID)23.06%
ProShares Decline of Retail (EMTY)7.78%
Proshares Short High Yld (SJB)3.95%
Proshares Short Bitcoin (BITI)-0.18%
Invesco CurrencyShares Euro (FXE)-2.52%
Franklin FTSE Brazil (FLBR)-3.97%
VanEck Vectors Pharma. (PPH)-4.95%
NightShares 2000 (NIWM)-6.46%
LeatherBack L/S Alt. Yld. (LBAY)-6.71%
Vanguard Value Index (VTV)-7.80%
Homestead Value Fund (HOVLX)-7.89%
Franklin FTSE Japan ETF (FLJP)-8.68%
[Benchmark] Vanguard 500 Index (VFINX)-9.21%
Vanguard FTSE Europe (VGK)-9.67%
Vanguard FTSE Developed Mkts. (VEA)-9.85%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)-9.96%
Franklin FTSE Germany (FLGR)-9.99%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)-10.17%
Vangaurd All-World Small-Cap (VSS)-10.79%
Vanguard Communications ETF (VOX)-12.50%
Franklin FTSE China (FLCH)-14.12%
Franklin FTSE South Korea (FLKR)-18.71%
Bond Funds1mo %
[Benchmark] Vanguard Total Bond Index (VBMFX)-4.18%
iShares JP Morgan Em. Bond (LEMB)-4.69%
Vangaurd L/T Treasury (VGLT)-7.91%
Vanguard Long-Term Bond Index ETF (BLV)-7.92%
Vanguard Extended Duration Treasury (EDV)-10.20%

August 2022 Performance Review

September 7, 2022

The rebound in stocks that started in mid-June ended in mid-August, and we’re almost back to square one – a bear market. The rebound was strong – a near 20% move up, but the drop is looking just as fast. As of September 6, the S&P 500 with dividends is down around 16.8% for the year, while the bond market is down a more surprising 11% – a big hit for bonds. Foreign stocks as a group are down over 20%; some much more.

Our Conservative portfolio declined 4.06% , and our Aggressive portfolio declined 2.35%. Benchmark Vanguard funds for August 2022 were as follows: Vanguard 500 Index Fund (VFINX), down 4.08%; Vanguard Total Bond Index (VBMFX), down 2.77%; Vanguard Developed Mkts Index (VTMGX), down 5.52%; Vanguard Emerging Mkts Index (VEIEX), up 0.23%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, down 3.61%.

Our Aggressive portfolio is down 11.37% for the year, which compares fairly well to the stock market, particularly foreign markets. For reference, at the end of August the global balanced Vanguard STAR was down 16.81% year to date. Our Conservative portfolio had a poor month and is now down 16% for the year under the weight of foreign stocks and longer-term bonds, both down in the 20%–30% range. That said, most low-credit-risk bonds likely can’t fall that much more from here, unlike stocks, which could easily drop another 20%+ if the Fed has to engineer a recession.

Some of our safer stock funds were the hardest hit in August. VanEck Vectors Pharma. (PPH) dropped 8%, while Franklin FTSE Germany (FLGR) fell 7.34%. Meanwhile, risky emerging market funds did okay, with Franklin FTSE Brazil (FLBR) up 6.47%, as Latin American funds were the #1 category last month of any fund types and one of only a handful of categories in positive territory in August. Our recently added or increased shorts helped our Aggressive portfolio offset losses. Proshares Short Bitcoin (BITI) was up 16.75% and Proshares Short High Yld (SJB) was up 4.28%, while UltraShort Bloom. Crude Oil (SCO) was up 8.72%. LeatherBack L/S Alt. Yld. (LBAY), which does some shorting, was down less than 1%.

What likely ended the stock rebound this summer was interest rates heading back up from the end of July. Stocks and real estate are heavily dependent on low rates. High rates cut into the profitability of companies and real estate as interest costs have to be deducted from revenues, but the more immediate problem is just relative valuation. If you can get 5% in a government bond or 4% in cash and CDs, levels we are approaching if rate increases keep up, why mess around with risky stocks?

There is a lot of focus on the troubles in Europe, but there is not enough focus on the potential troubles in our own housing market.

Europe has made a series of miscalculations that seem to be coming home to roost. Cutting back on nuclear energy because solar and wind are more popular (and don’t produce radioactive waste), magnified by the nuclear disaster in Japan, was a bad call for a region short on non-Russian energy.

Some of the sanctions seemed more designed to shame Russia and don’t do significant economic damage that could reduce the money flow into Russia that is used to finance the costly war in Ukraine. Shutting down McDonald’s doesn't hurt Russia. We took a US-owned asset that was drawing profits out and essentially gave it to Russia.

The main thing that needed to get done was lowering the price of oil and natural gas to reduce the flow of money to Russia. The West didn’t take the tough steps that would have caused a crash in oil – engineering a recession by raising taxes on energy temporarily. Instead, various states in the US reduced gas taxes or, in the case of California, are sending checks out under the guise of “inflation relief." The Federal Government just extended the pause on student loans and is planning on eliminating $10,000 of student debt per borrower.

The trouble is, these things will increase energy consumption and prices compared to doing nothing. It may seem counter-intuitive to raise prices with energy taxes, but with a supply-and-demand imbalance, the price is going to go higher anyway with the excess profits going to those that sell energy – like Russia. Since Europe already has near 10% inflation, slowing the economy down by driving energy demand down would have served two goals: reducing demand for Russian energy, and reducing inflation as any new tax would do sucking money out of the system (so long as it’s not spent on some sort of half-baked relief).

By deficit spending during high inflation, governments are kicking the can to central bankers (who don't have to face reelection) to solve the problems. We spent it, Fed; you unspend it because we don’t have the political will to take money away from crazed consumers.

The Fed has essentially three ways to reduce inflation: 1) scare people into speculating and spending less by talking about all the economic damage they are going to do; 2) raise shorter-term rates, which pushes up all sorts of consumer and business debt costs; 3) burn the trillions of newly created money they used to buy the debt that funded mortgages and PPP loans, also known as qualitative tightening or QT.

The Fed is trying #1 and #2 fairly aggressively, but #3 is next, and that is the one that scares investors the most. As it is, mortgage rates are going to head back up to 6% after a brief drop in recent weeks. If we go to 7% mortgages, in all likelihood we’ll have a recession and mini crash in real estate of 20%.

Home prices are as high as the last bubble, adjusting for incomes and payments. The Fed is likely aware of this and is scared to get too aggressive and would likely prefer inflation to drift down over a few years than risk a collapse in the real estate market. The best thing going for real estate and stocks now is the high inflation as rents and earnings are going up with everything else – rationalizing current high prices. If inflation runs at 8% a year for a few more years, and stocks and real estate prices remain the same, they will both be bargains, especially if mortgages remain at lower rates than inflation.

It is possible the falling stock and bond market will discourage the Fed from taking more aggressive action. It is likely if the recent rebound in stocks kept up to the old highs, the Fed would already be burning the new money, which they do by selling the bonds they bought for cash then erasing that cash from the world – the opposite of QE, or quantitative easing.

Gold, commodities, and even stupid crypto have been heading down again recently, which is what would be expected if inflation had peaked and is on the way back down.

The best case is what happened post WW2 when we had fairly massive inflation that didn’t last more than a few years, unlike the 1970s. The Fed didn’t do anything, and bond investors took the hit as inflation ate away at their investment and everything else was peachy for the next few decades.

The worst case is ugly: inflation doesn't ebb and global central banks, in an effort to prevent another 1970s, takes even more aggressive action and we go right back to a 2008 style asset crash.

Stock Funds1mo %
Proshares Short Bitcoin (BITI)16.75%
ProShares UltraShort QQQ (QID)9.75%
UltraShort Bloom. Crude Oil (SCO)8.72%
Franklin FTSE Brazil (FLBR)6.47%
Proshares Short High Yld (SJB)4.28%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)0.23%
Franklin FTSE China (FLCH)-0.40%
LeatherBack L/S Alt. Yld. (LBAY)-0.79%
Invesco CurrencyShares Euro (FXE)-1.76%
ProShares Decline of Retail (EMTY)-2.65%
Vanguard Value Index (VTV)-2.68%
NightShares 2000 (NIWM)-2.86%
Homestead Value Fund (HOVLX)-3.07%
Vanguard Communications ETF (VOX)-3.47%
[Benchmark] Vanguard 500 Index (VFINX)-4.08%
Franklin FTSE Japan ETF (FLJP)-4.31%
Franklin FTSE South Korea (FLKR)-4.33%
Vangaurd All-World Small-Cap (VSS)-4.67%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)-5.52%
Vanguard FTSE Developed Mkts. (VEA)-5.82%
Franklin FTSE Germany (FLGR)-7.34%
Vanguard FTSE Europe (VGK)-7.46%
VanEck Vectors Pharma. (PPH)-8.01%
Bond Funds1mo %
iShares JP Morgan Em. Bond (LEMB)-0.59%
[Benchmark] Vanguard Total Bond Index (VBMFX)-2.77%
Vangaurd L/T Treasury (VGLT)-4.46%
Vanguard Extended Duration Treasury (EDV)-5.15%
Vanguard Long-Term Bond Index ETF (BLV)-5.29%

July 2022 Performance Review

August 4, 2022

The stock market dip buying kicked in after a 20% drop (what is usually considered a bear market) driving the S&P 500 up almost 10% in July. Some of the excitement was that interest rates drifted down as inflation fears receded, sending the bond market up about 2.31% (with interest). Emerging markets were down, and the US dollar strengthened anew as our rates are quite a bit higher than other major economies, leading to inflows of money.

Our Conservative portfolio gained 1.77%, and our Aggressive portfolio gained 0.68%. Benchmark Vanguard funds for July 2022 were as follows: Vanguard 500 Index Fund (VFINX), up 9.22%; Vanguard Total Bond Index (VBMFX), up 2.31%; Vanguard Developed Mkts Index (VTMGX), up 5.28%; Vanguard Emerging Mkts Index (VEIEX), down 0.87%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 6.08%.

The growing mentality of “the worst is behind us” is going to make it more difficult for the Federal Reserve to chip away at inflation by slowing the economy through higher rates. The Fed already achieved much by scaring speculative assets down 50-80% in crypto and so-called innovation stocks trading at sky-high valuations. Real estate even started to show signs of cooling off when mortgage rates pushed 6%. July’s market action sending interest rates back down and speculative assets back up — 20% or more in many cases — isn’t going to help lower inflation.

One problem with the “inflation is coming down soon theory so the Fed won’t have to go nuclear with rates” rosy scenario is that this indicates a weak economy. If prices stop going up with all the work at home and Covid productivity issues globally, then the consumer is tapped out and has cut demand to meet lower supply. How is that economy going to raise earnings to higher levels than the previous stock boom? The super rosy scenario model then must be that supply comes back to normal everywhere to meet still-high demand before the demand is hit too hard.

If home prices keep going up and crypto and speculative stocks get even close to levels of last year, we’re likely going to need even higher rates to stop inflation from being closer to 10% than the supposed target of 2%. It would be in everyone’s best interest if consumers cut back on spending (and we’re seeing some signs of that) and investors didn’t go back into full gambling mode. If the Fed doesn’t care about asset prices and inflation starts heading down from the current level of higher interest rates, then stocks (and real estate) will work out for investors from these levels. This is a somewhat risky proposition that doesn’t warrant significantly more money shifted to stocks at this time.

Our biggest drag in our funds last month (not including inverse funds) was China, the single worst fund category of the month out of over a hundred fund categories. Our Franklin FTSE China (FLCH) holding was down 10.44% for the month. Our recent shifts in the portfolio didn’t benefit us, and our portfolios had lackluster returns relative to the market, notably our aggressive portfolio. As the S&P 500 beat more than 90% of funds last month, this is somewhat to be expected, but our new positions didn’t do well, so far.

While the S&P 500 was way up near 10%, newly (re)added Vanguard Communication ETF (VOX) was only up 3.71% compared with the QQQ ETF up 12.55% last month. This ETF now owns some hard-hit tech names, notably a 35% combined stake in just Facebook and Google. One big difference is that the S&P 500 and QQQ have large stakes in Tesla, which is enjoying a stock resurgence back to near $1 trillion after a 50% drop from the top reversed course with a 50% increase from the bottom a few weeks ago (which still leaves the stock down 25% from the highs last year or worse than the S&P 500). Tesla now is worth more than double Facebook (META) while Facebook trades at just 13x earnings, and Google 21, compared with Tesla’s 100+.

This is how valuable perceived future growth is relative to current earnings and the possible lack of potential growth in what is still clearly a market obsessed with the future.

Speaking of the future, crypto and related stocks were up around 30% last month. This is particularly strange given that the inflation story is supposed to be behind us and we’ve seen at least a dozen significant hacks and Ponzi grade collapses in the last few months in various crypto projects and funds. This is on top of some research noting that around 80% of all crypto coins or tokens were scams that went to near zero.

One thing the Fed learned in 1929 is that kicking up interest rates doesn’t shake speculative confidence that quickly. Does it matter if rates are 1% or 5% if you think you just bought the next Apple or the digital money of the future? If you think homes can go up 10% a year forever, is a 6% mortgage expensive?

Stock Funds1mo %
[Benchmark] Vanguard 500 Index (VFINX)9.22%
Homestead Value Fund (HOVLX)6.69%
Franklin FTSE Brazil (FLBR)6.41%
Franklin FTSE Japan ETF (FLJP)6.12%
Vangaurd All-World Small-Cap (VSS)5.92%
Vanguard FTSE Developed Mkts. (VEA)5.29%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)5.28%
Vanguard Value Index (VTV)5.06%
Vanguard FTSE Europe (VGK)5.00%
Franklin FTSE South Korea (FLKR)4.09%
Vanguard Communications ETF (VOX)3.71%
Franklin FTSE Germany (FLGR)2.57%
LeatherBack L/S Alt. Yld. (LBAY)1.06%
VanEck Vectors Pharma. (PPH)0.40%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)-0.87%
NightShares 2000 (NIWM)-1.46%
UltraShort Bloom. Crude Oil (SCO)-1.53%
Invesco CurrencyShares Euro (FXE)-2.55%
Proshares Short High Yld (SJB)-6.58%
ProShares Decline of Retail (EMTY)-7.58%
Franklin FTSE China (FLCH)-10.44%
ProShares UltraShort QQQ (QID)-22.36%
Proshares Short Bitcoin (BITI)-25.16%
Bond Funds1mo %
Vanguard Long-Term Bond Index ETF (BLV)4.44%
Vangaurd L/T Treasury (VGLT)2.62%
Vanguard Extended Duration Treasury (EDV)2.39%
[Benchmark] Vanguard Total Bond Index (VBMFX)2.31%
iShares JP Morgan Em. Bond (LEMB)-0.20%

June 2022 Trade Alert

July 8, 2022

We made some trades in both model portfolios on June 30th, 2022. The end result was a slight increase in stock and interest rate exposure by moving from shorter-term bonds to longer-term bonds, which are more sensitive to interest rate changes. This means that a 1% increase in rates equates to a bigger drop in price. We also made some changes to our hedging to protect the portfolios from an increasingly likely drop in higher credit risk debt, aka junk bonds. There just isn't the kind of selling from funds going on to mark a great buying opportunity even with the bear market decline.

Before we get to the trade detail, here is a quick summary of June 2022 returns:

Our Conservative portfolio declined 4.77%, and our Aggressive portfolio declined 4.89%. Benchmark Vanguard funds for June 2022 were as follows: Vanguard 500 Index Fund (VFINX), down 8.26%; Vanguard Total Bond Index (VBMFX), down 1.50%; Vanguard Developed Mkts Index (VTMGX), down 9.61%; Vanguard Emerging Mkts Index (VEIEX), down 4.43%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, down 6.25%.

Although it was nice falling roughly 60% as much as the S&P 500 and less than the Vanguard STAR fund, which is a total balanced portfolio of global bonds and stocks, this was still a pretty big hit for us as stocks and bonds are falling globally. We are down 9.85% for the year in our aggressive portfolio, or about half the S&P 500 drop. Our conservative portfolio at -13.93% is less impressive but is more interest rate sensitive and doesn't have offsetting short positions. Year to date, Vanguard Star Fund (VGSTX) is down 18.64% to the end of June.

The only fund category that was up in June was China region funds, which have been very weak until recently. Even hot commodity focused categories and countries like energy funds and Brazil funds have been down sharply. Gold, the supposed safe haven from global turmoil and inflation, is down about 15% from its peak a few months ago. Our only strong showing last month (other than short funds) was Franklin FTSE China (FLCH), up 8.59% and now "only" down 10.57% for the year. Compare that to Franklin FTSE Germany (FLGR), down 16.18% for the month and just under 30% for the year, and you can see how much more economic risk Europe is in than China with Russia and rising energy prices. It is unlikely China can avoid a recession in Europe and the United States, so these recent market moves are more the west catching up to the declines in China.

The reason for the turnaround in commodities-oriented investments is that the writing is on the wall and the Fed is likely going to keep raising rates until inflation starts definitely heading back toward 2%—which could take some time. Without the White House cutting spending or raising taxes, it will take high rates to suck back the maybe $10 trillion handed out globally as stimulus during COVID. It was dangerous and unnecessary for the Fed to keep buying mortgage bonds, recently sending the 30-year mortgage under 3% during what has been fast becoming another real estate bubble. The new higher mortgages could cause a real estate crash, particularly in commercial space that, in the case of offices, barely makes sense at current rent prices due to the new hybrid work schedule.

The S&P 500 is now in a bear market down around 20% for the year. Long-term bonds are down about as much, highlighting the difficulty for risk reduction with a balanced portfolio when interest rates are near zero with little room to go but up. Growth and tech areas are down around 30% or more. So far, it has been a good year to be in value stocks and cash.

Normally, this would be a good time to increase risk significantly as we did during the COVID crash in the early 2020, but this trade does not do that. We're holding out for another 10—20% drop and buying longer-term bonds while avoiding most higher credit risk bonds. It is likely we will be doing another trade in a few months if the market keeps sliding. If the Fed turns out to still be a so-called dove, inflation remains high, and short-term rates don't go much higher, we may miss a turnaround in the market, and this will be another 20% drop dip buying opportunity like during the end of 2018.

The Trades

All bonds are down this year, with longer-term bonds down around 20%. We cut back on longer-term bonds during the COVID crash, and our initial move to inflation adjusted bonds was a good call. Perhaps we got out of these bonds too soon fearing the risk of inflation expectations collapsing if the Fed got aggressive on fighting inflation, which didn't really happen yet.

Now with all rates rising rapidly, our shorter-term investment-grade mortgage bond fund is down a whopping 8.8% for the year through the end of the June. This was better than the even overall bond market down just over 10.35% and less than half the 21.40% slide in Vanguard Long-Term Bond Index ETF (BLV) a long-term bond fund that we cut back on post-COVID.

Long-term bonds have declined about the same as the S&P 500 (so far), down around 20% including dividends. Speaking of, the yield on the S&P 500 is up but still only around 1.65%, and the bond market as a whole now pays a far more healthy 3.5%. Although it is possible that interest rates will continue up to meet higher inflation, realistically the bulk of the hit to bonds is behind us, and any moves to say 4—5% will reverse when the next recession kicks probably from the higher shorter-term rates. If the Fed chooses to allow more high inflation, it is unlikely interest rates will rocket higher to say 7% just to continue to pay less than inflation—which is no great situation but still warrants owning 3—5% yielding bonds as the stock market risk is higher than bonds if the Fed overshoots.

We've discussed this poor situation in bonds since early 2020. When cash yields zero and the bond market yields less than 2%, your offsetting gains from a stock slide are essentially nil. This is why a bond and stock blend did so poorly in the early 2020 COVID crash, and this year (so far). In hindsight, when we reduced our stake in long-term and inflation adjusted bonds (for this very reason), we should have just gone to cash and not for the paltry yields in mortgage bonds. This is easy to say now, but earning zero while the Fed decides what to do isn't a great solution. It would have made more sense to own more stocks, less bonds, and more hedges.

If stocks go significantly lower from here, it is more likely that bonds will do well (not junk bonds, but investment-grade and government debt), so the benefit of a balanced portfolio will return.

NEW HOLDINGS ADDED TO BOTH PORTFOLIOS

Leatherback Long/Short Alternative Yield ETF (LBAY)

Aggressive Portfolio from 0% to 3%

Conservative Portfolio from 0% to 5%

This new fund was launched last year and broadly speaking is somewhat similar to a fund we've used off and on in client accounts, Vanguard Market Neutral (VMNFX). These funds mostly own value-type stocks and short high-flying growth stocks with questionable fundamentals like Carvana (CVNA) to name one of hundreds. This strategy can work in normal markets but is best during deflating bubbles. It is a disaster during times like 2020 and 2021 when hot bubble stocks get hotter, as you can see from the bad performance of Vanguard Market Neutral (VMNFX). We're pretty late in the deflating tech bubble game with roughly 80% declines across the board, but this strategy still offers potential for a late-stage decimation and 99% drops in many speculative tech names. VMNFX is the lower risk (less overall market exposure) and probably the better choice but has a high minimum, so we are not using it here. LBAY probably has more upside (and downside) risk. Unlike most of our holdings, we may not keep this fund for over a year, so consider it in an IRA in case there are short-term gains. Also the fund has a regular dividend payout strategy, which is basically a marketing gimmick.

Vanguard All-World Small-Cap (VSS)

Aggressive Portfolio from 0% to 9%

Conservative Portfolio from 0% to 5%

Foreign stocks are now very cheap, though they face high risks from a deep recession as many do not have secured domestic energy supplies and rely heavily on Russia. This, plus rising rates and slowing economies as well as dealing with multidecade high inflation, makes times look even rougher abroad than here. This is also why these prices should work out in the longer run. Many of these markets are almost in single-digit PE ranges, and dividend yields are more than double the United States. Small cap stocks abroad are even more out of favor probably because of the large cap index focus of most investors when investing abroad.

Proshares Short High Yield (SJB)

Aggressive Portfolio from 0% to 5%

Conservative Portfolio 0% to 7%

High-risk bonds will fall hard if the economy slides into a deep recession. Safer bonds could actually improve in price, so it is possible that we'll make money on this fund and our longer-term investment-grade bond funds. There is little risk in the short run of this fund falling significantly and losing money in investment-grade bonds, which would require the spread between low- and high-risk debt to shrink.

We don't usually have inverse funds in our Conservative portfolio, but we need protection from further troubles in the bond market. This fund is a safe way in the short run to do that. See Aggressive portfolio for more explanation.

SELL ALL IN BOTH PORTFOLIOS

Vanguard Mortgage-Backed Securities (VMBS)

Aggressive Portfolio from 20% to 0%

Conservative Portfolio 30% to 0%

While we were right to cut back on longer-term bonds and go to shorter-term safe bonds, there was still too much interest rate risk here, and we should have just stuck it out in cash or 1-year bonds. We could continue to hold this fund, but we're going to move more to long-term bonds (which have more downside risk if rates keep going up). The fund was down 8.88% for the year.

Vanguard Utilities (VPU)

Aggressive Portfolio from 10% to 0%

Conservative Portfolio from 10% to 0%

We're cutting back on lower-risk stock funds that are yield focused. These funds are attracting too much money as investors shift out of growth. This fund was down just 1.23% for the year, so it served its purpose during this bear market.

AGGRESSIVE PORTFOLIO ONLY

Overall: 62% stocks to 63% stocks, bonds from 34% to 21% (but more rate risk) alternative from 0% to 3%, and inverse 4% to 11% (largely from adding inverse junk bonds).

Click here to visit the Aggressive Portfolio's trade center.

AGGRESSIVE PORTFOLIO ADD NEW HOLDINGS

Vanguard Telecom VIPER (VOX) from 0% to 10%

We've owned this fund for years but cut it loose long ago as a too-early exit from tech bubble valuations. The issue was that the communications indexes started adding Facebook and Google, which does make sense on some level but also exposed the fund to high-risk stocks instead of the usual Verizon- and AT&T-type holdings.

Fast forward to today, and these stocks are all way down. A few days ago, this fund was down around 40% from the highs last September. Keep in mind more speculative tech names are now down 50—90% pretty much across the board. Can they go lower? Definitely, earnings are going to be a problem at even tech monopolies as ad spending from money-losing bubble-era startups gets cut in a desperate attempt to get profitable. Still, these prices are attractive, and we can add more if this isn't the bottom.

ProShares Short Bitcoin Strategy (BITI) from 0% to 2%

Too bad this inverse Bitcoin fund wasn't launched before the 70% drop in bitcoin, as we've been noting this bubble for years here. It would seem this bubble is almost fully popped, but Bitcoin, unlike say a tech index, can go far lower. This fund should do well as inflation fears disappear as the whole narrative of 0% rates is fast ending. Since there are few ways to short commodities and inflatable assets, this offers an, albeit strange, deflation bet. In many ways, sharply falling inflation is worse for stocks than high inflation and is outright deadly for real estate. That said, crypto investors have cultlike behavior and may not sell even in the face of 70% declines and crypto accounts being frozen or falling 99%.

Leatherback Long/Short Alternative Yield ETF (LBAY) from 0% to 3%

This new fund was launched last year and broadly speaking is somewhat similar to a fund we've used off and on in client accounts, Vanguard Market Neutral — VMNFX. These funds mostly own value-type stocks and short high-flying growth stocks with questionable fundamentals like Carvana (CVNA) to name one of hundreds. This strategy can work in normal markets but is best during deflating bubbles. It is a disaster during times like 2020 and 2021 when hot bubble stocks get hotter, as you can see from the bad performance of Vanguard Market Neutral Fund (VMNFX). We're pretty late in the deflating tech bubble game with roughly 80% declines across the board, but this strategy still offers potential for a late-stage decimation and 99% drops in many speculative tech names. VMNFX is the lower risk (less overall market exposure) and probably the better choice but has a high minimum, so we are not using it here. LBAY probably has more upside (and downside) risk. Unlike most of our holdings, we may not keep this fund for over a year, so consider it in an IRA in case there are short-term gains. Also the fund has a regular dividend payout strategy, which is basically a marketing gimmick.

Ultrashort Bloomberg Crude Oil (SCO) from 0% to 2%

This fund generates K-1 partnership tax paperwork, not a 1099, so it should be in an IRA. Unfortunately, there are very few ways to short commodities with ETFs or funds anymore—most are too small or too leveraged. This is too bad as the real risk now is a collapse in the economy and the new commodity bubble. Bottom line, if stocks fall another 20%, it will likely happen as oil falls back to $50. There is some risk of the Russia situation sending oil up to $150, in which case we may double down on this position. We owned a similar fund during the last great recession-era commodity crash and did well.

AGGRESSIVE PORTFOLIO REDUCE HOLDINGS

Vanguard Value Index (VTV) from 14% to 6%

The value boom relative to growth might not be over, but we don't need such a big weight here anymore. This fund was only down 9.29% for the year, or about half the S&P 500. We're not ready to get back heavy into the Vanguard Growth ETF Vanguard Growth ETF (VUG), which was down around 30.37% for the year, but perhaps soon.

AGGRESSIVE PORTFOLIO INCREASE HOLDINGS

iShares JP Morgan Em. Bond (LEMB) from 4% to 7%

We cut this fund back from 8% to 4% back in late February 2021 as it was riding high after the COVID rebound. We probably should have gone to zero like in the Conservative portfolio. Anyhoo, now that the fund is down sharply (around 15% for the year and about 25% since we cut it back) with over 7% yields, it is time to go increase the position, though there are big risks in high-yield bonds that hopefully we're covering with our new short high-yield bond ETF. There is potential to make money here when our dollar sinks from multidecade highs. In general, reaching for yield in a potentially teetering economy is a bad idea.

CONSERVATIVE PORTFOLIO ONLY

Overall: 42% stocks to 44% stocks, bonds from 48% to 32% (but more rate risk) alternative from 10% to 17%, and inverse 0% to 7% (from adding inverse junk bonds).

Click here to visit the Conservative Portfolio's trade center.

CONSERVATIVE PORTFOLIO ADD NEW HOLDINGS

NightShares 2000 (NIWM) from 0% to 5%

This new fund (launched in the last few weeks) is a bit of a gimmick based on a historical anomaly. Typically we don't like data mining to create a fund because, by the time you get around to marketing a fund, the money that has been made in this anomaly goes away—or even reverses . Many things work on paper until enough people start doing it. Sometimes such patterns work during certain markets and do the opposite during others—the Dogs of the Dow strategy where you simply focus on the highest yielding stocks in the Dow worked great, until growth stocks started to lead the market in the late 1990s (and again until recently).

That said, this anomaly may not go away for another year or so, and this strategy should be lower risk than owning a straight small cap stock fund as we did post-COVID crash. We're going to have to watch it closely for a possible sale. This fund should be tax-inefficient from constant realized short-term capital gains, so consider it in an IRA.

The fund only owns stocks (through futures) at night, in this case the small cap Russell 2000 index. The pattern has been that, if you buy stocks near the end of the market close, say 3:50 p.m., and sell the position at 9:30 a.m. when the market opens, you earn a better risk adjusted return than the market. There are hypotheses and white papers about this, which doesn't make it any more certain as a strategy for the future of course. Our theory is that it is partially the result of day traders coming into stocks in the morning often with leverage and getting out by the end of the day, artificially boosting prices in the morning, depressing them near the end of the day, and causing a generalized irrational fear of the overnight. But retail day traders have largely been destroyed since the 2021 peak in growth stocks. We'll have to watch this one closely for asset growth or the end of the era of this scheme working. There are other problems like tax inefficacy that almost require this in an IRA.

Vanguard Long-Term Treasury Index (VGLT) from 0% to 8%

Not much to explain here—as rates go up and bonds tank, we're moving into longer-term bonds that have the most upside if rates go back down, say in the next recession. The only way long-term rates go much higher from here is if the Fed stops raising short-term rates and doesn't sell off many of the bonds acquired with newly created money and essentially remains a dove. It could happen, but it is not that likely. Meanwhile, 3%+ yields are worth some risk, unlike 1%.

CONSERVATIVE PORTFOLIO INCREASE HOLDINGS

Vanguard Extended Duration Treasury (EDV) from 10% to 14%

This is the recession buster holding because the interest rate exposure is so extreme, meaning changes in interest rates lead to huge changes in the fund price. The fund does best when rates go down for safe bonds as is often the case in a recession and when inflation expectations decline. We sold some of this fund post-COVID when rates were ultralow then bought some back early in 2021 (too early as it turns out). This fund is down 28.11% YTD more than the S&P 500 and almost exactly what the Nasdaq is down from the highs. If long-term rates go up more, we'll increase our position again.

Invesco CurrencyShares Euro (FXE) from 10% to 12%

Eventually we're going to stop raising rates, and then other countries with rising inflation are going to go up and our hot dollar is going to sink back down. In the meantime—go to Europe on a trip as the Euro is around parity (1 USD — 1 Euro) with the dollar, the best deal in decades for travelers.

Vanguard Long-Term Bond Index ETF (BLV) from 8% to 10%

This has a similar explanation to new holding Vanguard Long-Term Treasury Index (VGLT), only we don't want to increase our corporate bond position that much quite yet—this fund includes government and corporate investment-grade bonds, which explains the slightly higher yield.

Franklin FTSE South Korea (FLKR) from 5% to 7%

Our last trade here was cutting back in February 2021 after a big move up (basically a double). Now with a slide of 25% YTD in 2022 and about a 36% drop since we cut back, we're increasing the position again. The fund portfolio has yields of over 3% and a P/E ratio under 10 or about half the valuations of the S&P 500—not that cheapness magically saves you from losses in a global panic or recession, but it can reduce your losses when bubbles burst, at least compared to other options.

 

Stock Funds1mo %
ProShares UltraShort QQQ (QID)16.73%
Franklin FTSE China (FLCH)8.59%
ProShares Decline of Retail (EMTY)6.19%
Invesco CurrencyShares Euro (FXE)-2.46%
VanEck Vectors Pharma. (PPH)-3.02%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)-4.43%
Franklin FTSE Japan ETF (FLJP)-6.97%
Vanguard Value Index (VTV)-7.91%
[Benchmark] Vanguard 500 Index (VFINX)-8.26%
Homestead Value Fund (HOVLX)-8.39%
Vanguard FTSE Developed Mkts. (VEA)-9.20%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)-9.61%
Vanguard FTSE Europe (VGK)-9.95%
Franklin FTSE South Korea (FLKR)-14.11%
Franklin FTSE Germany (FLGR)-16.18%
Franklin FTSE Brazil (FLBR)-19.28%
Bond Funds1mo %
Vanguard Extended Duration Treasury (EDV)-1.42%
[Benchmark] Vanguard Total Bond Index (VBMFX)-1.50%
Vanguard Long-Term Bond Index ETF (BLV)-3.19%
iShares JP Morgan Em. Bond (LEMB)-3.31%

May 2022 Performance Review

June 5, 2022

A late-month rebound in stocks stopped May from being as bad as April. This reversal is probably because interest rates took a break from the dramatic rise this year, a rise that has taken most bond funds down 5%—20% in value. Foreign stocks did a little better last month than the tech-heavy US market, which has been under significant pressure since this market turned south at the beginning of this year. May was a good month for our portfolios, especially relative to US markets.

Our Conservative portfolio gained 1.50%, and our Aggressive portfolio gained 2.12%. Benchmark Vanguard funds for May 2022 were as follows: Vanguard 500 Index Fund (VFINX), up 0.18%; Vanguard Total Bond Index (VBMFX), up 0.58%; Vanguard Developed Mkts Index (VTMGX), up 1.73%; Vanguard Emerging Mkts Index (VEIEX), up 0.62%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 0.69%.

We're still down almost 10% in our Conservative portfolio YTD, which is a rough year compared to the 12.78% hit to the stock market. Our Aggressive portfolio is down a more respectable 5.22% for the year.

Much of the froth in the stock market around supposedly innovative stocks of the future is now gone, although many still need to go to zero like in the 2000—2002 washout. The most trendy growth stocks are now mostly down 50%—90% from highs. The Nasdaq was recently down shy of 30% year to date before the recent rebound (still down over 20% YTD). For the record, the Nasdaq was down around 40% in 2000—the year the tech bubble popped—though, from the peak in March 2000, the Nasdaq fell around 50% (and 75% top to bottom in 2002). Last month, technology-oriented funds were down about 3% and 28% for the year.

In general, stock valuations globally aren't that bad. This will likely only be a good entry point if interest rates stick around these levels and we avoid a recession. Safe bonds are now reasonably priced at roughly 3% yields. Although 3% sounds like a terrible deal with near 10% inflation, the days of almost guaranteed positive returns adjusting for inflation in safe assets are gone. One way or the other, inflation will return to sub 3%, and bonds should more or less break even with inflation. We remind you to buy your yearly allotment ($10k max per person) of Series I Savings Bonds direct from the US Treasury.

If inflation doesn't start to fall, global central banks will have to keep punishing the market—not just the stock market but the housing market. In theory, if governments raised taxes and cut spending, we'd get a balance in supply and demand, but in practice the Fed is probably going to have to raise rates higher than inflated asset prices can handle.

We're close to moving back out on the yield curve to longer-term bonds—into the fire. The next leg down in bonds will likely be high-yield junk bonds—the authentic proof a recession is around the corner. We may also increase our foreign stock allocation, though there will be no immunity from a recession by investing abroad.

All of our holdings except Vanguard Extended Duration Treasury (EDV), which was down 4.03% last month (and down 21% since added back to portfolios in February), beat the S&P 500 in May (except our short QQQ fund), which reflects how much of this slide is tied to mega-cap US growth stocks. Our top performer last month was the recently volatile Franklin FTSE Brazil (FLBR), up 7.15%. In theory, this fund will be a winner from high global commodity prices that need to come from places that are not Russia, but there is risk in any emerging market for a worldwide recession that lowers all prices. This fund would be a good holding for a soft landing economically, meaning one where central banks can ease us off high inflation without a deep recession.

Our second-best holding was Franklin FTSE Germany (FLGR), up 5.16%, rebounding off a significant drop this year. With increasing talk of cutting way back on Russian energy, Germany is in a precarious position economically now. The one that got away, energy funds are still delivering this year as oil goes ever higher on a still-hot economy with supply issues. Energy funds are the top area this year, up 45% for the year and 13% last month. Too bad we cut back a few months ago. The worst place is digital asset-oriented funds, down around 50%. Too bad they didn't make a crypto token backed by oil instead of ones supported by... another crypto (and now down 99.9%).

Other big losers for the month include real estate funds, down around 5% as rising rates and a slowing economy place risks on this area beyond making the yield less attractive. It is still unclear what is going to happen to commercial real estate if this hybrid work structure sticks because, long term, it will create a glut in office space that won't be easy to fix with lower rates, unlike the last crash in commercial real estate.

Our third best holding Vanguard Utilities (VPU), up 4.51%, is due for a cut as investors swinging out of risky growth stocks have landed on safe income stocks, and the relative value is falling fast here.

The next shoe to drop, if there is one, will be high-yield bonds, notably floating-rate debt that investors feel is safe because the yields reset with short-term rates. The trouble in this area, which we do not have direct exposure to as in floating rate or bank loan funds, is shaky as companies won't be able to make these payments if rates rise too far, especially if we get a weak economy and high short-term rates. The good news is the loan you made to me now pays 7%, not 4%. The bad news is I can't afford 7%. Defaults will go up, way up.

There is a broader issue here with our margin loan economy. With low rates below inflation and far below historical price increases in real estate and stocks, it made sense to borrow against your stocks to buy real estate or just have money to spend. Why pay tax selling stocks that should go up 5%—15% a year forever when you can borrow against this portfolio at 3%, tax-deductible? Stock-backed loans are how many tech billionaires avoid tax and finance lavish lifestyles for a long time. Recently this financial engineering has been marketed to the rich but not the island-owning rich by banks. Such securities-backed loans are everywhere on balance sheets, on top of the near trillion dollars in ordinary stock margin loans, a record.

The banking system seems secure because today's real estate loans are much safer. Low down payment adjustable rate "loser" loans to those lying about their income (No Income, No Job NINJA loans) are more or less gone from the system. Now the homes are backed by solid folks sitting on millions in stocks.

This is all fine and dandy until stocks fall 50% or more. We may never expose this weak link in the economic chain, but if we do, it could be as bad for real estate and stocks as 2008. It has been quite some time, 1929 to be exact, since excessive stock leverage has led to economic and market problems. Banks don't remember, but customers with high credit scores swimming in assets can default quickly as subprime borrowers if conditions turn very dark.

In the meantime, the Fed isn't going to be there to support a crash unless inflation cools off. The market, for the first time in 30+ years, is flying without an insurance policy.

Stock Funds1mo %
Franklin FTSE Brazil (FLBR)7.15%
Franklin FTSE Germany (FLGR)5.16%
Vanguard Utilities (VPU)4.51%
ProShares Decline of Retail (EMTY)4.28%
Vanguard FTSE Europe (VGK)2.41%
Homestead Value Fund (HOVLX)2.41%
Vanguard Value Index (VTV)2.41%
Franklin FTSE China (FLCH)2.25%
VanEck Vectors Pharma. (PPH)2.17%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)1.73%
Franklin FTSE Japan ETF (FLJP)1.72%
Vanguard FTSE Developed Mkts. (VEA)1.65%
Invesco CurrencyShares Euro (FXE)1.64%
Franklin FTSE South Korea (FLKR)1.42%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)0.62%
[Benchmark] Vanguard 500 Index (VFINX)0.18%
ProShares UltraShort QQQ (QID)-1.15%
Bond Funds1mo %
Vanguard Mortgage-Backed Securities (VMBS)0.91%
[Benchmark] Vanguard Total Bond Index (VBMFX)0.58%
iShares JP Morgan Em. Bond (LEMB)0.48%
Vanguard Long-Term Bond Index ETF (BLV)0.23%
Vanguard Extended Duration Treasury (EDV)-4.03%

April 2022 Performance Review

May 5, 2022

Ouch. Global markets are not in the mood to fight inflation, and the market reaction to the Fed press conference of May 4th only highlights the growing fear of the world of waning global monetary stimulus. Stocks and bonds were down sharply across the board in April as inflation shows no signs of abating without action — the kind that slams the economy and markets. The real story isn't the near-double-digit hit to stocks, but the near-double-digit hit to bonds. These fears are rational. Inflatable assets like commodities, real estate, and stocks often do very badly when inflation heads back down. Bonds do badly when inflation isn't in check. If both are down, then the assumption is that the higher rates in the bond market are going to "work" in cooling inflation.

Our Conservative portfolio declined 5.72%, and our Aggressive portfolio declined 5.54%. Benchmark Vanguard funds for April 2022 were as follows: Vanguard 500 Index Fund (VFINX), down 8.72%; Vanguard Total Bond Index (VBMFX), down 3.85%; Vanguard Developed Mkts Index (VTMGX), down 6.55%; Vanguard Emerging Mkts Index (VEIEX), down 5.55%; and Vanguard Star Fund (VGSTX), a total global balanced portfolio, down 7.43%.

In hindsight, when we cut back on inflation-adjusted bonds (which we went into last year when rates and inflation were low), we should have just parked half the portfolio in cash instead of mortgage bonds. Like everyone, we were scared of nearing zero on cash for years waiting for higher rates or lower stock prices. Well, higher rates came fast — about as fast as the 1994 and late 1999 bond mini crash. Long-term government bonds were down about 9% in April — more than stocks — and are down around 20% for the year as of now. The good news for investors is now you can earn 3% safely. Over time, this is better than if rates remained 1%.

Before you get too scared, keep in mind the bond market isn't going to fall 50% like stocks can from here. Some ultra-long-term zero coupon government bonds may fall briefly. If bonds fall much harder, it will be brief, at least for government bonds. In such a crisis, the Fed would switch to money creation and bond buying again (and hasn't even started selling off the bonds purchased with new money during the COVID crash).

This is a leveraged world with sky-high asset prices based on low rates. The U.S. government can't afford our debt at 7%, and neither can anybody else. The "good" news for the government is they just inflated away 10% of the debt or maybe $2 trillion. Without almost guaranteed inflation of over 5% a year, nobody can afford to buy a high-priced home with a 7% mortgage. Sure we've had 10% mortgages "in the past," but then homes were priced at 2 times average incomes; today it is more like 4 times. In many hot real estate markets, that number is 10 times.

Current bond yields are actually not a bad deal in the long run as we will likely, hopefully, return to sub-3% inflation, and in general low default risk bonds probably won't pay more than inflation for long periods of time ever again — as we've noted here before.

Some commodity funds were up a little last month, but 99% of fund categories were down. Commodity funds won't do well if inflation heads back down and we get a recession, but they will do well if inflation remains above 4% with the economy remaining hot. The hardest hit areas included foreign stocks and growth stocks. Tech stocks are in a bear market, and technology category funds are down close to 25% for the year. As noted before, this doesn't even capture the full-on 2000 grade crash in stocks of the future or so-called innovation investments. These are now down 50% to 90%. Many will go to zero.

Our inverse Nasdaq fund is finally paying off with a 45% gain YTD. This has partially offset big losses in bonds and stocks, notably in our remaining long-term bonds and foreign stocks. Our China fund Franklin FTSE China (FLCH) is down 19.46% for the year. As proof of the pain in bonds, our Conservative portfolio is down 10.95% for the year, while our Aggressive portfolio is down just 5.54%, as opposed to the near 13% drop in the Vanguard 500 fund and a whopping 13.81% year to date drop in Vanguard Star Fund (VGSTX), which highlights the hard hit to bonds and foreign stocks this year. That's right, diversifying into bonds and foreign stocks actually increased downside in 2022, so far. Our strongest areas include VanEck Vectors Pharma. (PPH), down just 2.25% for the month and up 1.31% for the year, followed by utilities, which were basically flat for the year after Vanguard Utilities (VPU) slid 4.38% for the month.

The Federal Reserve Chairman press conference from April 4 made little sense. Initially, there was a massive spike in stocks, which (so far) abruptly reversed on April 5 during one of the wildest two-day sessions in a long time.

The Fed is in a tough spot. They probably feel that this inflation is sort of phony as it results from distortions in supply and demand and that if they react to aggressively it will cause a depression, yet they can't keep saying "transitory" and doing nothing. Imagine if the government decreed three-day weekends for workers for a year and sent bonus checks to all workers every few months. We'd have inflation. Should the Fed raise rates and cause a recession to fix it? Isn't the fix either get used to higher prices as supply and demand adjust or go back to work 5 days a week and stop sending stimulus checks (or deferring loan payments)?

The gist of the message from the first in-person Fed press conference since COVID was that the legislators aren't to blame even though they are the ones who handed out checks and encouraged working less during shutdowns. The high inflation is all the Fed's world — and the Fed will deal with it. No more Mr. Nice Rate Guy — inflation must be brought down to save the little guy. We don't work for Goldman Sachs! This strong message was followed up with fairly weak action and a near guarantee that shorter term rates won't go up that fast or that much — because we sure don't want to cause a recession to fight the worst inflation in 40 years.

The wild card to higher rates is the increasingly bizarre government support of stretched consumers and borrowers. There is no telling what a pandering state or federal government will do if mortgage rates hit 6% on a 30-year fixed rate mortgage — already well over 5%, which is a big move up from around 3% or lower just a few months ago. Perhaps we'll get checks in the mail to subsidize bigger mortgage payments for new home buyers — why not? We got oil released from the Strategic Petroleum Reserve and essentially handouts to car owners in CA and gas tax breaks in Republican states because gas prices went up. The consumer must always be coddled! Higher prices and rates won't work in slowing demand if we get subsidized for high prices.

Bottom line, in the short run, rates may go up more to counter the Fed's lazy response to inflation caused by Congress. Bond holders are getting nervous. This will start hitting stocks harder than bonds, though we could see a bond fund rush to the exists (again). Ultimately we'll slide into a recession if rates get too high, and bonds will go back up with rates down as inflation fears morph into deflation fears (again).

If the federal government isn't going to address inflation caused by supply and demand imbalances, the Fed needs to raise short-term rates faster than planned to prevent long-term rates from going up too fast — basically reassuring bond investors that inflation is going away so you can safely buy a 3% government bond. Losing the long end means 6% mortgages and recession.

Stock Funds1mo %
ProShares UltraShort QQQ (QID)29.91%
ProShares Decline of Retail (EMTY)0.99%
VanEck Vectors Pharma. (PPH)-2.25%
Vanguard Utilities (VPU)-4.38%
Invesco CurrencyShares Euro (FXE)-4.72%
Vanguard Value Index (VTV)-4.79%
Franklin FTSE China (FLCH)-5.17%
Homestead Value Fund (HOVLX)-5.51%
[Benchmark] Vanguard Emerging Mkts Stock Idx (VEIEX)-5.55%
Vanguard FTSE Europe (VGK)-6.25%
[Benchmark] Vanguard Tax-Managed Intl Adm (VTMGX)-6.55%
Franklin FTSE South Korea (FLKR)-6.62%
Vanguard FTSE Developed Mkts. (VEA)-6.79%
Franklin FTSE Japan ETF (FLJP)-7.86%
Franklin FTSE Germany (FLGR)-8.01%
[Benchmark] Vanguard 500 Index (VFINX)-8.72%
Franklin FTSE Brazil (FLBR)-13.21%
Bond Funds1mo %
Vanguard Mortgage-Backed Securities (VMBS)-3.59%
[Benchmark] Vanguard Total Bond Index (VBMFX)-3.85%
iShares JP Morgan Em. Bond (LEMB)-4.71%
Vanguard Long-Term Bond Index ETF (BLV)-9.49%
Vanguard Extended Duration Treasury (EDV)-12.57%